Lazy Portfolios

Lazy Portfolios are passive investing techniques that use a diversified set of index funds to perform well in all market conditions. Such portfolios are suitable for most investors during the accumulation phase of their lifetimes as they typically possess 30-40% bonds. They require very little maintenance (rebalancing once or twice a year) and due to low fees associated with index funds, frequently outperform actively managed funds as well as the S&P 500 more generally. An even simpler way to have a lazy portfolio is simply to choose Vanguard LifeStrategy or Target Retirement funds (don't pay attention to the year in the name, choose based on your preferred bond allocation) and perhaps supplement it with an index fund or two to skew it in the direction of your liking.

Why have they performed so well? The key is that these portfolios offer protection against the downside and should perform well in a variety of market conditions, unlike the S&P 500. Since the stock market has been in a bearish phase the past five years, these portfolios have greatly outperformed. This may not continue in the future, but there is nobody that can predict the future, and these portfolios offer true diversification, which is key to long-term sustained reliable growth.

(Update: Looking at the portfolio performance through 10/27/09 when the S&P 500 is up over 28% in the last year further strengthens the argument to hold such diversified portfolios.Although the market has been on a tear the past year, all of these funds except one have outperformed the S&P 500 despite that fact that most hold 30% or more bond funds; admittedly, bonds have also had a huge upswing in recent months. Aronson Family Taxable and Second Grader's Starter have approximately outperformed the S&P 500 by 10% in the past year. As they say, past performance does not guarantee future results. However, these results illustrate how these portfolios can perform well in bear and bull markets over the long-term. See graph to the right for complete results through 10/27/09.)

Some investors may want to supplement a lazy portfolio with individual stock picks if they have the time and knowledge base to do so. Just don't expect to pick winners every time - studies have shown that few people can reliably do so. But having 90% of your portfolio dedicated to a Lazy Portfolio and 10% dedicated to individual stock picking seems reasonable to me if you have the desire to do so. Note that these portfolios contain anywhere from 3 to 11 funds, all of which offered by Vanguard as they are the flagship low-cost index fund provider. Some of the funds are repetitive and can be consolidated (e.g. owning small growth and small value can just as easily be held by owning twice as much small blend) to get around the $60,000 minimum portfolio size required of the 11-fund portfolios.

There is no need to blindly follow such portfolios without considering your own personal goals and risk tolerance. The exact percentages are also not important - being in the ballpark is what is significant and rebalancing once a year is preferred. Using these as guides and modifying them slightly to suit your own needs is actually ideal, in my mind.

In addition, these don't specify if they are held in taxable or tax-deferred (i.e. retirement accounts) except for the Aronson Family Taxable. These should thus be seen as overarching percentages of all accounts combined. Based on tax-efficient investing, one should place certain securities in their retirement account over a taxable account and vice versa. For example, REIT funds should be exclusively in retirement accounts, bond funds should mostly be in retirement accounts due to tax inefficiency (except for muni bond funds), while the majority of your equity stake should be in taxable accounts. Consult this bogleheads wiki article for Principles of Tax Efficient Fund Placement and particulars.

Let's further examine the asset allocation of these eight portfolios more closely based on data available from the MarketWatch site.

Aronson Family Taxable

Ted Aronson manages $25 billion of assets with AJO Partners

11 funds

0.27% aggregate weighted net expense ratio

70% Stocks / 30% Bonds

15% Vanguard Pacific Stock Index (VPACX)

15% Vanguard Inflation-Protected Securities Fund (VIPSX)

15% Vanguard 500 Index (VFINX)

10% Vanguard Extended Market Index Fund (VEXMX)

10% Vanguard Long-Term Treasury Fund (VUSTX)

10% Vanguard Emerging Markets Stock Index Fund (VEIEX)

5% Vanguard High-Yield Corporate Fund (VWEHX)

5% Vanguard Small-Cap Growth Index Fund (VISGX)

5% Vanguard European Stock Index Fund (VEURX)

5% Vanguard Total Stock Index Fund (VTSMX)

5% Vanguard Small-Cap Value Index Fund (VISVX)

Comments: One could easily combine 15% VFINX and 5% VTSMX to just 20% VTSMX as they are essentially the same. Likewise, you could combine 5% VISGX and 5% VISVX to be a 10% stake Vanguard Small-Cap Index (NAESX). These consolidations would make this a more manageable 9-fund portfolio. The small value and growth funds used to track different index than the small blend, but they have since all been aligned to track the same benchmark so performance should be similar. Note the absence of an REIT fund that is popular in the other Lazy Portfolios. This is most likely because this portfolio is explicitly for taxable accounts.

Fundadvice Ultimate Buy & Hold

Paul Merriman of FundAdvice.com

11 funds

0.29% aggregate weighted net expense ratio

60% Stocks / 40% Bonds

20% Vanguard Intermediate-Term Treasury Fund (VFITX)

12% Vanguard Short-Term Treasury Fund (VFISX)

12% Vanguard International Value Fund (VTRIX)

12% Vanguard Developed Markets Index Fund (VDMIX)

8% Vanguard Inflation-Protected Securities Fund (VIPSX)

6% Vanguard Small-Cap Index (NAESX)

6% Vanguard Small-Cap Value Index Fund (VISVX)

6% Vanguard Value Index Fund (VIVAX)

6% Vanguard 500 Index Fund (VFINX)

6% Vanguard Emerging Markets Stock Index Fund (VEIEX)

6% Vanguard REIT Index Fund (VGSIX)

Comments: Again, the exact percentages are not imperative. This is a more conservative portfolio with 40% bonds, and skewed towards shorter duration treasuries (which I generally prefer as well).

Dr. Bernstein's Smart Money

Dr. William Bernstein is a financial adviser for HNW individuals and wrote an article outlining this portfolio in SmartMoney ten years ago

9 funds

0.26% aggregate weighted net expense ratio

60% Stocks / 40% Bonds

40% Vanguard Short-Term Treasury Fund (VFISX)

15% Vanguard Total Stock Index Fund (VTSMX)

10% Vanguard Small-Cap Value Index Fund (VISVX)

10% Vanguard Value Index (VIVAX)

5% Vanguard Emerging Markets Stock Index Fund (VEIEX)

5% Vanguard European Stock Index Fund (VEURX)

5% Vanguard Small-Cap Index (NAESX)

5% Vanguard Pacific Stock Index (VPACX)

5% Vanguard REIT Index Fund (VGSIX)

Comments: Again, skewed towards short-term treasuries as well as small-cap, value, and emerging markets (typically, Europe accounts for 50% of total international funds, Pacific is 30%, and EM is 20%). Fairly conservative with a 40% bond allocation, all of which is going to Short-Term Treasuries, a non-diversified bond portfolio. I personally would swap in Vanguard Short-Term Bond (VBISX) or Vanguard Total Bond Market (VBMFX) for VFISX for increased diversification.

Coffeehouse

Bill Schultheis is a former Smith Barney broker and author of The Coffeehouse Investor

Comments: This is a super simple, four fund evenly split portfolio. It again skews towards small-cap, but doesn't have any exposure to Pacific, emerging markets, or REITs, which I feel can offer potential for increased returns and diversification. With increased globalization of the financial markets, European and US Markets typically correlate very well. It's the emerging markets that typically differ. Replacing Vanguard European Stock Index Fund (VEURX) with Vanguard Total International (VGTSX) or Vanguard FTSE All-World ex-US Index (VFWIX) would be a wise decision, in my opinion. Then, adding a small position in Vanguard REIT Index (VGSIX) (reducing the small-cap fund percentage by the same amount) would make this a great 5-fund portfolio.

Margaritaville

Scott Burns developed this portfolio for the Dallas Morning News

3 funds

0.26% aggregate weighted net expense ratio

67% Stocks / 33% Bonds

34% Vanguard Total Stock Index Fund (VTSMX)

33% Vanguard Total International Stock Index Fund (VGTSX)

33% Vanguard Inflation-Protected Securities Fund (VIPSX)

Comments: This is also an incredibly simple portfolio that makes a lot of sense. This overweights the international market more than all-in-one funds such as LifeStrategy or Target Retirement funds, and provides exposure to nearly every part of the world. This portfolio is also a good hedge again increased inflation, which is not a bad bet in this current economic status. But the bond allocation certainly isn't diversified.

Second Grader's Starter

3 funds

0.23% aggregate weighted net expense ratio

90% Stocks / 10% Bonds

60% Vanguard Total Stock Index Fund (VTSMX)

30% Vanguard Total International Stock Index Fund (VGTSX)

10% Vanguard Total Bond Market Index (VBMFX)

Comments: Similar to the Margaritaville portfolio, except the TIPS fund has been substituted with a TBM fund. This portfolio has underperformed the others not as a function of its simplicity, but due to its high exposure to equities (90%) unlike the other portfolios. Obviously, stocks have underperformed in the past five years. One could easily use this strategy as a starting point and skew it to the appropriate bond allocation based on your objectives and risk tolerance. (A typical bond allocation is your age in bonds or some say 110 minus your age equals an appropriate stock allocation.) If this had simply been a 33%/33%/33% split, it would have performed remarkably similar to the Margaritaville portfolio over the 5-year period. The total bond market index is more diversified and thus less volatile than the TIPS fund. Over the past 5 years, TBM has returned 5.18% annually, while TIPS have returned 4.67% annually. So, it would have outperformedMargaritaville had it had the same bond allocation. This is a Lazy Portfolio I highly recommend based on its simplicity, broad diversification, low expenses, and easy flexibility. I do like some exposure to REITs in retirement account, however, and this has none. Adding Vanguard REIT Index Fund (VGSIX) to this three fund portfolio to create a tailored four fund portfolio would make a lot of sense.

Investing Guy's Lazy Portfolio

6 funds

0.25% aggregate weighted net expense ratio

70% Stocks / 30% Bonds

25% Vanguard Total Stock Index Fund (VTSMX)

25% Vanguard Total International Stock Index Fund (VGTSX)

20% Vanguard Total Bond Market Index (VBMFX)

10% Vanguard Inflation-Protected Securities Fund (VIPSX)

10% Vanguard REIT Index Fund (VGSIX)

10% Vanguard Small-Cap Value Index Fund (VISVX)

Comments: This portfolio utilizes my preference for the a small-cap/value tilt on US equities, as well as exposure to REITs and TIPS. It also exposes you to foreign small caps unlike the other Lazy Portfolios as this should provide greater diversification and expected return. (Note: This statement is no longer true since Total International now includes small-cap international. See more details below). I attempt to keep it as simple as possible to make re-balancing and accounting easier, while also exposing you to nearly all portions of the market. (Some may argue that commodities are missing, but this is an area that shouldn't be touched by the average investor.)

The bond percentage is not a one size fits all, in my opinion. You should adjust that percentage (just increase or decrease VBMFX) based on your age, timeframe to retirement, and risk tolerance, and modify the rest accordingly. I use VFWIX over VGTSX (Total International Market) since it is slightly more tax-efficient (eligible for the foreign tax credit since it holds securities directly) and contains Canada (6%) unlike Total Int'l. However, VGTSX recently changed from being a fund-of-funds to also holding the stocks directly, so its tax efficiency should be nearly the same as VFWIX going forward and the blurring between these two funds gets even stronger. (I'd expect Vanguard eventually combines them.) If you want to slightly overweight Emerging Markets by holding a small position in Vanguard Emerging Markets Stock Index Fund (VEIEX) or further slice and dice into a Vanguard Developed Markets (VDMIX)/VEIEX blend instead of a single holding in VFWIX, that would look good to me as well.

As stated above, I recommend holding some small-cap international through a fund such as Vanguard FTSE All-World ex-US Small Cap Index (VFSVX; ER 0.78%; 0.75% purchase and redemption fees) or ETF such as VSS (ER 0.55%), Schwab International Small-Cap ETF (SCHC; ER 0.35%), or iShares MSCI EAFE Small Cap (SCZ; ER 0.4%). All are good choices, although too much slicing and dicing can over complicate your portfolio, so if this makes things harder to keep track of and maintain for you, then it's best to avoid it. Keep it simple. I'd see nothing wrong with moving that 5% to the large cap international fund (VFWIX) to make large cap international a full 25%. The various funds and ETFs mentioned at the beginning of this paragraph may track different indicies, so that's something to be aware of, although the differences will most likely be small. A reasonable percentage of small-cap international is about 20-25% of your total international holdings. (Simply reduce or increase your large-cap international holding by the same amount. That is, keep your total international target the same.) Thus, if you have a relatively small portfolio (<$100,000), then your small-cap international holding probably won't make a significant difference in the long run.

Update 10/25/10: Vanguard is adjusting their Total International Index (VGTSX) to track the MSCI All Country World ex USA Investable Market Index in the near future. This new fund will include the market share of small-caps (~15%) and thus is a perfect all-in-one solution for foreign exposure. This fund's investor expense ratio is 0.32% and will also be offering admiral (>$10,000 investment) and ETF class shares for even cheaper. When these changes will take place it still uncertain, but people are speculating they will occur sometime in Q1 2011.

Update 1/31/11: Vanguard's international fund now follows the above mentioned index. Thus, I have modified it to simply including one international fund instead of a large-cap international and small-cap international. Fewer holdings should make it easier to track.

If the seven funds make it too complicated to re-balance, keep track of, or dollar cost average for you, I'd go with a VTSMX (40%), VBMFX (25%), VFWIX VGTSX now (25%), and VGSIX (10%) portfolio assuming you want a 75/25 stock/bond split. That four fund portfolio (as I said in the comments for Second Grader's Starter) is perfect for many individuals and I recommend it highly. Vanguard recommends holding 20-40% of your equity stake in foreign markets, and I have it at approximately the 36% mark, if you count REITs as part of US equity (which some may and others may not). The market cap of non-US equities has climbed to 59% of the global market cap (check out the X-Ray of Vanguard Total World Stock Index, VTWSX) and Vanguard suggests that as an upper limit. However, their analysis indicates there is incremental benefit in having more than 40% in international stock based on the increased risk (such as currency volatility), so they substitute 40% as the recommended upper limit. Just choose something you are comfortable with and stick with it. Try to hold as much of the bond and REIT portions of your portfolio in tax-advantaged accounts as these are not very tax efficient. Stock funds are very tax efficient so you should hold these in taxable accounts.

Overall comments: Note the expense ratios hover around 0.25%. That is certainly very low, but still above Target Retirement funds which are approximately 0.20%. This 0.05% difference is only $5 difference a year for every $10,000 invested, so it's certainly nothing to worry about, but the point is that from a fund expense standpoint, the self contained fund-of-funds indexing (i.e. TR funds) is not any worse than the do-it-yourself approach (i.e. Lazy Portfolios). Also note that these expense ratios are for investor class shares, but Vanguard reduced the investment amount to qualify for the lower-cost Admiral shares to only $10,000 in October 2010. Thus, if your portfolio is a decent size, you could easily take advantage of these lower costs and lose even less of your investment gains to fees.

The Lazy Portfolios just give you more flexibility to choose the percentages as you see fit and allow you to hold the funds in a more tax efficient manner. One should be aware of the potential tax consequences of holding bond funds in taxable accounts if you go the single fund approach. It's also interesting to examine some commonalities between the various portfolios; they are typically skewed towards small-cap, value, REITs, international, emerging markets, short-term treasuries, and/or TIPS moreso than the TR/LifeStrategy Funds.

Here is a graphical representation of all the eight aforementioned portfolios' asset allocations based on the categories of the particular funds:

You can dissect these and go back and forth on what you think is the best approach forever, but in the end, just choose a strategy and stay the course. One is not significantly better than the other; the key thing to determine is your age and tolerance for risk, which should determine your bond allocation. Don't deviate from your plan. That has proven time and time again to be catastrophic. Choosing one of these portfolios requires perhaps a one hour time commitment a year to rebalance and monitor the performance. It's really a great way to beat those attempting to time the market, make individual stock picks, etc. And you'll rest easy at night and have time to dedicate to more important things in life.

If you want to dollar cost average over time into funds and don't want to rotate which fund you set up for an automatic investment plan, it might make sense to invest in a Target Retirement or LifeStrategy fund that has an appropriate allocation of bonds and then supplement it with index funds that you find appropriate. These funds contain the Total US Stock Market, the Total Bond Market, the European Market, Pacific Market, and Emerging Markets. You can supplement that core holding with small-cap, value, TIPS, REIT, and perhaps more international equities or short-term treasury funds. It's easy to personalize it and you can dollar cost average into the core fund, which won't significantly alter your asset allocation.

Do some research and choose a Lazy Portfolio that's right for you or create your own. You won't regret it.

34 comments:

Good question Rick. Unfortunately, VFWIX and VFSVX are relatively new so a backtest cannot go back very far. However, I have looked at it using fairly equivalent ETFs - in particular, utilizing VTI, VBR, AGG, TIP, EFA, EEM, DLS, and VNQ.

According to a backtest conducted on etfreplay.com, the ETF-equivalent portfolio to the Investing Guy's Lazy Portfolio has a 1-, 3-, and since inception (6/16/2006) returns of 13.5%, -0.7%, and 19.5%, respectively, with volatility values of 14.9%, 20.8%, and 18.9%, respectively. That inception date is the farthest I could go back due to DLS - I don't know of another International Small-Cap Index ETF that began earlier.

This compares to the S&P 500 returns of 13.5%, -11.1%, and 7.8% with 18.1%, 30.4%, and 26.1% volatility, respectively. As you can see, the Investing Guy's Lazy Portfolio has outperformed the S&P 500 considerably in the 3-year (+10%) and inception (+12%) time ranges with much less volatility. The 1-year returns are identical, but the Lazy Portfolio has achieved this less volatility (i.e. taking on less risk).

For more comparison, I chose two other Lazy Portfolios somewhat at random - Margaritaville and Coffeehouse. The Margaritaville portfolio has returns during the same time periods of 9.5%, -3.3%, and 21.7%, with volatility levels of 13.6%, 18.5%, 17.6%. The Coffeehouse portfolio has returns during the same time periods of 14.2%, 3.9%, and 20.0%, with volatility levels of 12.9%, 17.9%, and 16.0%.

Based on this historical data, all three Lazy Portfolios have performed better than the S&P 500 - the Coffeehouse has performed the best of all four, with the Investing Guy's Lazy Portfolio next, Margaritaville next, and the S&P 500 last. Past performance does not guarantee future results. They will probably swap positions of "best" over different time periods, but the key thing to take note is that they all achieve results superior to the S&P 500 while taking on less risk and volatility.

Thanks Rick. You definitely make a good point. The ETFs I used above weren't necessarily a suggested portfolio, but rather ETFs that have enough historical data to backtest. (My default was using the Vanguard ETF, and I chose something else if it wasn't old enough.) Certainly, going the all iShares route makes sense if you have an account with Fidelity, while using solely Vanguard ETFs is logical if your account is held there. It's surely wise to avoid as many trading fees as possible.

On a somewhat related note, I don't know how iShares gets away with charging 0.72% for its Emerging Markets ETF (EEM) and 0.35% for its Developed Markets ETF (EFA), but the rest of their commission-free ETFs with Fidelity are quite low cost and competitive. Thus, I wouldn't sweat it too much unless my total portfolio was quite large and the international holdings (particularly emerging markets) were a significant portion.

Getting back to the main topic, I don't have a paid account with etfreplay.com and I am still able to use their backtest functionality. They did, as you alluded to, get rid of the ability to save portfolios on the free version. Now you now have to manually enter them each time you want to conduct a test, but in this case entering 8 or so tickers isn't too time consuming. Also, I'd use IWN instead of IJR (if you're trying to get small-cap value exposure). IJR follows the S&P SmallCap 600 Index, while IWN follows the Russell 2000 Value Index. (VBR tracks the MSCI US Small Cap Value Index).

This is very similar to the above ETF portfolio. The one year has a 0.1% difference, while the three-year return is 0.9% behind. By the way, since 12/12/2007, the portfolio I used first has a return of -1.0% with 20.6% volatility. If I were to hold this portfolio exclusively at Vanguard right now I'd use VTI, VBR, BND, VEU, VSS, VNQ, and the mutual fund VIPSX (no TIPS ETF at Vanguard).

Fantastic article, much appreciated! I'm in the midst of restructuring my asset allocation to a "lazy" portfolio structure and have found your entire site extremely useful.

Any thoughts on whether to avoid bonds or replace them with something else? There seem to be a lot of people indicating that the bond market is heading for rough waters. Or does this question come too close to a tactical investing approach?

I'm all for buying and rebalancing once a year but must admit that it's nervewracking - as I kick off my new portfolio - putting significant $ into something that's supposedly stable that could result in significant losses...

Thanks for the kind words! Your concern is a very common one right now and there is a lot of talk about a bond bubble. A few comments on that. First, if the potential for losses in your bond holdings make you a nervous wreck, then your equities should cause you to have a heart attack! I know I exaggerated your emotions - that comment wasn't meant to be derisive, but rather to suggest that it's always important to put things in the proper perspective. The term "significant losses" is subjective and even in a doomsday scenario for bonds, the losses would pale into comparison to the potential losses and risk involved with investing in stocks. To further illustrate this point, check out the Growth of $10,000 chart of VBMFX courtesy of Morningstar since 1986:

Since 1986, the most severe pullback was the big "bond bubble" of 1994, which produced a maximum loss of about 4%. Compare it to VTI (Vanguard Total Stock) for even more perspective. Google Finance reports VBMFX's worst three-month return as -3.00%. Could we see performance even worse than those historic ones? Of course. But the volatility of bonds in general is still paltry compared to bonds even in this time of low interest rates.

Having said all that, I don't think your concerns are without merit. When interest rates rise (and they will undoubtedly rise unless we fall into a similar situation to Japan in the 90s with low interest rates for a long period), your bond funds will take a hit in the short-term. The longer duration of the fund, the bigger the hit. However, as long as you hold your bond fund longer than the average duration, you should still end up ahead of the game and not really be concerned with losses over the long-term.

Check out this article from Vanguard, which suggests that rising interest rates actually benefit investors over the long-term as long as you reinvest your interest income.

They conclude: "[I]f you're holding bond funds as part of your long-term asset allocation, a rise in rates probably shouldn't prompt you to make any changes. Indeed, you can benefit by sticking with the bond allocation that's right for you."

Also check out these two Vanguard articles:https://personal.vanguard.com/us/insights/article/bond-bubble-08032010 (Should you beware of a bond bubble?)

http://www.vanguard.com/pdf/icrrol.pdf (Risk of loss: Should investors shift from bonds because of the prospect of rising rates?)

So, now that we have a perspective that over the long-term rising interest rates aren't that huge of a concern and also that the potential of a short-term downfall of bonds is perhaps overhyped, I'll respond to the question to the best of my ability. Vanguard certainly holds the position that individual investors are best served by maintaining their asset allocation and holding for the long-term, since reinvesting interest income will put you ahead. This is undoubtedly true. If you're a long-term investor, shouldn't you only be concerned with the long-term performance? Easier said than done. So, I'll also provide a contrarian viewpoint.

Here's a nice blog entry from the Finance Buff:

http://thefinancebuff.com/2010/08/you-should-still-beware-of-a-bond-bubble.html (You Should Still Beware of A Bond Bubble)

(See next entry for the end of my response. My response was too long to fit in one comment!)

The Finance Buff posits that if interest rates go up as expected, bond values will go down. It doesn't matter that the losses are small compared to the potential losses in equities - it's still a loss. And while it's true that reinvesting interest income in your bond funds over the long-term will benefit you in a rising interest rate environment, the Finance Buff argues that the returns would have been even better if you sidestepped the short-term rise in interest rates and invested in bonds at a slightly later time.

I think both perspectives have a valid point. Interest rates are going to go up; it's just a matter of when. When that occurs, your bond fund's NAV will take a hit. The longer-term duration funds will take a larger hit than the shorter-term ones. Over the long-term, this temporary hit will be compensated by reinvesting interest income at higher rates and you'll end up ahead if you stay the course.

Bonds are held to moderate volatility and increase diversification. Thus, you obviously don't want to replace your bond position with equities under any circumstance. This definitely is a "tactical investing approach" question, but I don't think that's always a bad thing. It's good to have confidence in your investing choices.

If you are uncomfortable with potential for short-term losses in the bond portion of your portfolio, I think there are two viable alternatives.

1.) Shorten the duration of your bond holdings. Instead of selecting a Total Bond Market Index fund (VBMFX has avg duration of 4.7 yrs), choose a short-term index like VBISX (2.6 yrs). This will cut the potential for short-term losses in half. (Obviously, at the expense of expected returns. There is no free lunch.)

For more information on how bond prices interact with interest rates, see this bogleheads article:

http://www.bogleheads.org/wiki/Bonds:_Advanced_Topics#Duration

"For example, a bond with a duration value of 5 years would be expected to lose 5% of its market value if interest rates rose by 1% (100 basis points)."

Thus, while the total bond fund might lose 5% of its value, the short-term indices would lose only 2.5%.

2.) Use CDs as an alternative. This is what the Finance Buff suggests.

Or use a combination of the two above. I think that's reasonable. Or even all three if it's a significant sum of money - keep a total bond, short term, and CDs. Spread your money across the strategies.

In the end, while the above two options will reduce the chance for a significant short-term pullback and you'll be less affected by the potential "bubble," you will NOT be able to time it perfectly as to when to get back in the bond market. Thus, you'll miss some opportunity and whether you come out ahead will largely be determined by luck.

Thus, if you're simply interested in your long-term performance, stick to your asset allocation plan. If you're concerned about short-term volatility in the bond market, it's reasonable to shift to shorter durations and/or CDs and then re-assess this position as time goes on. Will you come out ahead? Maybe. Will your short-term volatility be decreased? Yes.

Great article and I appreciate all the information! I’m a recent college graduate interested in saving and investing for my future and retirement. I had a question on developing a portfolio based on the Swensen/Yale Unconventional Model. What would you think of a fund composed of the following 5 funds? Do you see any major problems or missed diversification opportunities?

I have two main questions after reading your article as well as researching other places on my own?

1) Can the Vanguard Total International Stock Index Fund (VGTSX) be substituted for the two funds: Vanguard Developed Markets Index Fund (VDMIX) and Vanguard Emerging Markets Stock Index Fund (VEIEX) and still offer as much access to Pacific and emerging markets?

2) Can Vanguard Total Bond Market Index Fund (VBMFX) be substituted for the three treasury funds listed above: VFISX, VFITX, VIPSX? Or does the Total Bond Market Index Fund not include what the other 3 provide by having each separately in your portfolio? Or instead of investing in the Vanguard Total Bond Market Index Fund (VBMFX) would it be better to just invest in the Vanguard Long-Term Treasuries Fund (VUSTX)

If you have time to glance at this any wisdom or advice you’d have to offer would be most welcome. Thanks again for the great information you provide.

Hey Ryan! Thanks for the kind words, and I’m glad you found my blog helpful. Coincidentally, another reader also asked about the Swensen portfolio today in the comments section of my Comparison of Vanguard, Schwab, and Fidelity post. I’d check out my response there as there is a lot of overlap.

I think the five fund portfolio you proposed is a good one. Note that, as mentioned in the other comments section, Swensen has recently modified his recommendation of the percentage dedicated to REITs, reducing that by 5% to 15% and upping the emerging market holding by 5%.

Now to answer your two main questions.

1.) Yes. Vanguard Total International Stock Index effectively holds VDMIX and VEIEX at market weights which is about 25% Emerging and 75% Developed. You don’t lose any diversification by simply going the one fund route and I recommend it to simplify matters and perhaps get you to admiral level (>$10,000) faster, which subsequently charges lower fees. Vanguard recently changed the index that VGTSX follows and it includes small-caps at market weight as well Canadian stocks. It’s a GREAT all-in-one international fund. The only reason you’d want to hold VDMIX and VEIEX individually was if you wanted a different percentage dedicated to emerging markets than the 25% of your international holdings. Note that in the original Swensen model, he had it at exactly 25%. However, as stated above, he has upped that recommendation to 40%. Emerging markets are more volatile and risky, so you need to decide what’s best for your objectives. All else being equal, I’d recommend market weight and simply holding VGTSX. Note that it’s also considerably cheaper going the one fund route because VEIEX is a bit more expensive and charges a 0.50% purchase fee as well as a 0.25% redemption fee. If you do decide to hold an emerging market only fund, I’d recommend the equivalent ETF, VWO, to avoid purchase fees.

2.) Not really. I mean, VBMFX certainly can be substituted for those three funds and is a reasonable choice as an all-in-one bond fund, but it does not contain the same holdings. VBMFX contains only about 43% Treasury bonds, while Swensen recommends one’s bond portfolio to be 100% treasuries. He completely neglects corporate bonds and the like, arguing that the bond portion of a portfolio is not where risk is meant to be taken and treasuries are the safest choice. I personally disagree and like the increased diversification that corporate bonds bring. It’s not as if VBMFX contains junk bonds so it’s still a safe choice. If you want more a middle ground, however, I’d recommend checking out VBIIX, Vanguard Intermediate-Term Bond, which is essentially VBMFX without the mortgage-backed bonds. Some consider MBSs unnecessarily risky as evidenced by the 2008 crisis and VBIIX contains about 60% treasuries. I would not recommend holding solely VUSTX. As stated in the other post, Swensen himself actually now recommends holding VFISX (70%) and VUSTX (30%) (in addition to TIPS). If you want my personal opinion, I would recommend VBMFX or VBIIX, which both can be supplemented with VIPSX. Since you are early in your career, some say owning TIPS (VIPSX) is not as necessary since your income should rise with inflation.

(See continuation of response below. My post was too long and the system wouldn't allow a single comment).

Some people might say a 30% bond allocation is too high for a 22-year old (although perhaps you’re a bit older than that). I’d probably agree and argue for 20 or 25% bonds (reduce VIPSX and add to VTSMX).

Note that the above asset allocation requires a $30,000 portfolio due to the $3,000 fund minimums. If you have a 6-month emergency fund on top of $30k to invest this early, well then you’re off to a great start! If not, you have a few options:

1.) Consolidate holdings at Vanguard for now and purchase the funds with smaller allocations later. You might just want to start with a three-fund VTSMX/VGTSX/VBMFX portfolio and then you can buy the other two when you have more assets.2.) Use another brokerage firm that has lower minimums like Charles Schwab, which only requires a $100 investment.3.) Open a Vanguard brokerage and use the equivalent ETFs which trade commission free. Just make sure to use limit orders. Some people dislike the extra work involved with placing orders during the day and the fact that you can’t buy fractional shares, but others prefer the added flexibility. So, it just depends. Note that if you have less than $50k in total assets, Vanguard charges you a $20 annual fee for a brokerage account. That certainly won’t break the bank, but is something to be aware of.

Personally, I’d go the #1 route if you fall under this scenario. I hope that helps! Good luck!

Thank you very much for the advice and your own recommendations. Since I’m just starting my professional career out of college, I’m not making tons of money but I do make a point to save up and max out my Roth IRA each year (so far I’ve done it for 2009, 2010, and 2011). That is where I plan on starting this portfolio. I’m a slightly cynical young adult who is under the belief that I won’t have Social Security when I retire, so I’m starting early and will hopefully save and make enough by the time I retire, that I’ll have a fairly nice pre-taxed nest egg. I’m sure none of the lazy portfolio models were designed to be put in a Roth IRA, but since I don’t have tons of extra money to invest with beyond my Roth IRA, that’s where I’m starting my investments. I figure that the models will work just as well inside a Roth IRA with the added benefit of not paying taxes on whatever these funds make me over the years to come.

simply because, as you said, the $3,000 minimum makes it difficult to acquire each fund while only being able to contribute a max of $5,000 a year to my Roth IRA. That is why I asked about using VBMFX instead of having the three funds VFISX, VFITX, VIPSX. I am aware that the more funds I have in my Roth IRA portfolio, the longer it will take for me to be able to afford those funds since I can only buy 1.66 funds each year essentially.

Currently I own VTSMX, VGTSX, and VGSIX. I bought them in that order because I wasn’t sure where to put my money in bonds yet, and I’ve heard TIPS funds (VIPSX) aren’t terribly important at my age. I bought the VGSIX fund most recently because the housing market is still pretty poor and I figured I’d ride the economy and the fund on the upswing as it improves.

I know Roth IRA’s are good accounts for bonds and REIT’s because they are tax inefficient and I know stocks are pretty tax efficient so they probably don’t belong or need to be in a Roth IRA for tax purposes. However since I’m only investing within my Roth IRA right now, I think it is a good place to start diversifying my portfolio. In future as my portfolio grows, I can always sell the stocks in my IRA and reinvest them in bonds and REIT’s, while simultaneously reallocating my portfolio and investing and moving my stocks out of my Roth IRA if it would make more sense for taxes or for maximizing my retirement funds.

As for the 3 options your recommended. I currently have my Roth IRA with TD Ameritrade, but once I realized they have transaction fees for all the funds I want, I think I’ll be moving my Roth IRA to Vanguard. I figure they will give me the best deals and lowest fees since I’ll be investing in their funds. I also have almost a year’s emergency fund saved up with no college, credit card, or car debts. So I’m trying to stay financially responsible and save for my future, hence all my questions for you. Thanks again for your advice!

Ryan, it sounds like you're off to a great start and have a good plan in place. Congrats!

It appears that you are unaware that TD Ameritrade now offers 101 ETFs commission free (started in October of last year). While you are correct that the mutual funds have transaction fees, there are suitable ETFs that require NO MINIMUM investment (and no transaction fees). As long as you're comfortable placing limit orders, I'd check them out.

If you'd rather start out and continue your investing with Vanguard, by all means, feel free to transfer the funds at this point in time. Just note that sometimes it can take several days and TD Ameritrade may charge you a transfer fee (usually around $75). It depends on the brokerage. Some make it easy and seamless, while others really make it difficult as to discourage you from transferring the assets. My point is simply that there are the same investment opportunities for free at TD Ameritrade as long as you go the ETF route (which may or may not be ideal for you).

And while your understanding of tax-efficient investing is spot on, it's not as if stock funds are bad to be placed in IRAs or other retirement accounts. It's simply that bonds are not great for taxable accounts and thus retirement accounts are the alternative. However, following your asset allocation is FAR FAR more important than practicing tax efficient investing. Having 80% stocks and 20% bonds has a much larger expected growth rate and after-tax return over the long-term than say 50/50, even if the 80/20 is invested inefficiently from a taxation standpoint. You seem to have that understanding, but just wanted to make it clear. Personally, I like investing my REIT and Small-Cap Value (i.e. tax inefficient but high risk, high reward asset classes) in my Roth IRA while holding bonds in a 401k. You want your Roth IRA to grow as much as possible since the withdrawals are tax free. A 401k (or traditional IRA), on the other hand, is tax deferred so you'd owe more upon withdrawals if you invested in the asset classes with higher expected returns. This doesn't apply to your situation, though, since you only have a Roth IRA so you need to have all holdings there, which is perfectly acceptable. Just thought I'd mention it for the future. Good luck again!

I posted a question yesterday about using a lazy portfolio in retirement and I left out some info that is probably needed. My retirement savings will initially provide about 1/3 of my annual income, with the remainder coming from Social Security and a traditional pension, which is fixed and will not increase with inflation. In my retirement savings, the cash cushion bucket I described equals about 1/6th of the total, and the growth bucket about 5/6 of the total. Thanks.

OOOPS, it appears I did not post my question properly yesterday, so here it is:

Thanks for sharing your insights and trenchant analyses in this article/thread, and others, which I just discovered while researching asset allocation and portfolio choices for retirement income.

Basic question: Does a lazy portfolio make sense for someone already (just) retired?

I’ll elaborate a little. I recently retired at 68 and in good health. For practical purposes, my retirement assets are all in tax-deferred accounts. (I have some money in Roth IRAs, but I plan to not use those funds, and leave them to children and grandchildren.) The tax-deferred money is in rollover IRAs at Vanguard, 75%, and Fidelity, 25% (some funds there have even lower ER and better performance than Vanguard).

At my current and projected withdrawal rates, the money will last 25 – 30 years, given modest growth over inflation. The question, can I reasonably expect a lazy portfolio to provide that growth?

I conceptualize the structure of my portfolio in two buckets: bucket 1 is a cash cushion with 4-5 years of cash equivalents (money market and treasury funds); bucket 2 is for growth & income to feed and maintain the cash cushion. Having bucket 1 cover 4-5 years of distributions and sitting in very low-yielding funds probably seems inefficient, even wasteful, to many observers. I view it as a hedge against a prolonged down market, my “security blanket” for sound sleep, and it’s much simpler for me than constructing a bond ladder.

So my question comes down to the viability of using a lazy portfolio for bucket 2 and using the annual rebalancing process to also “harvest” the best performers to replenish bucket 1 and maintain the cash cushion. I assume there may be occasional periods of two or three years of down markets when it may not be possible to fully replenish the cash bucket – that’s the reason for having that bucket cover four to five years of withdrawals.

Thanks for the comment, Steve. Yes, a lazy portfolio can make sense for somebody just retired - it's simply a matter of choosing the appropriate stock/bond allocation and keeping costs lows. It's definitely a good idea to keep your money in the Roth IRAs for children/grandchildren, since Roth accounts don't have any RMDs and thus offer great advantages for estate planning.

Your situation sounds a bit more complex with estate planning as a key factor, so I would recommend consulting with a (fee only) professional or go to a forum to get a multitude of opinions, like the Bogleheads forum where people can help you out for free:

http://www.bogleheads.org/forum/viewforum.php?f=1

But for your bucket 2, a lazy portfolio definitely would be a great choice. Since your retirement assets are all in tax-deferred accounts, you do not need to worry about tax efficiency at all.

Thus, you may want to consider something even lazier than the above proposed portfolios, and just a single fund like Vanguard Target Retirement Income (VTINX). These funds are rebalanced daily and thus don't require maintenance at all. And the net expense ratio is still a slim 0.17%.

VTINX contains 45% Total Bond, 21% Total Stock (US), 20% Inflation-Protected Securities, 9% Total International Stock, and 5% Money Market. That is definitely a reasonable blend for your desired goals growth and income. You get your income (70% of total portfolio) from the bond/money market (64% total bond, 29% TIPS, 7% cash) and growth (30% of total portfolio) from equities (70% US, 30% Foreign).

If you want to slice and dice to your liking, on the other hand, there's nothing wrong with that. Or you can make VTINX a core holding and supplement it with something (small-cap value, for example). And you're right that Fidelity has some great low-cost offerings. Their Spartan funds are good as well as some of the iShares ETFs that are transaction free. I created a table of the various asset classes and the lowest-cost index fund (and ETF) offering from Vanguard, Schwab, and Fidelity in this post:

Thanks! Yes, that does help, especially the suggestion to look into VTINX. I could see doing that with the money at Vanguard and using the money at Fidelity for some individual tilt. I recently discovered the Bogelheads and have done some trolling there, which I will continue. I have seen the comparison article you posted and will return for a deeper look. Thanks again!

Not enough information to make a full-fledged recommendation, but the most conservative TR fund is Vanguard Target Retirement Income, VTINX, which holds about 70% bonds/cash, so I'd start my search there. It's also the only Vanguard TR fund that holds TIPS, which is a nice addition to the portfolio. Seems to be a good choice for investors who are risk averse and don't need take on much risk to meet their goals. Good luck.

No problem. I think VSCGX (LifeStrategy Conservative Growth) would be a fine choice as well. Vanguard just changed the composition of its LifeStrategy funds actually to exclude the asset allocator fund which was making it tax inefficient (and a market timing instrument). Now the LifeStrategy funds simply have total bond, total stock, and total international - great move by Vanguard. VSCGX is 59% bonds, 29% total US, 12% total international. VTINX is 45% total bond, 20% inflation-protected bonds, 5% MMF (which is paying nothing right now), 22% Total US, and 9% Total International. Thus, VTINX at 70/30 bond/equities is more conservative than VSCGX at about 60/40 bonds/equities. But overall, their compositions aren't that different, and the choice simply depends on the stock/bond allocation that you desire (and the presence of TIPS). Either would be suitable in my mind.

If your assets are all in retirement accounts and thus tax efficiency isn't important, you might also want to check out Wellesley Income (VWINX), which is more dividend oriented and looks for value. Yes, it's an active fund, which I typically don't recommend, but it's relatively low-cost (still not as low as the above two mentioned funds) and has been carefully managed for several decades. It has $25 billion in assets under management. It's currently at 62% bonds/38% stocks, and varies between 60-65% in bonds.

Any of these three or a combination of them would be a good conservative and diversified portfolio, in my mind. They're all low cost and diversified, although Wellesley has only about 15% of its equities in foreign holdings while the other two have a more reasonable (in my opinion) 30%. If you can't decide, you could even split the difference and invest half in VSCGX and the other half in VWINX. Or even a third in each, although that seems a bit redundant with VTINX and VSCGX having three of the same holdings. Wellesley has Admiral shares (lower expense ratio) for investments greater than $50k.

In addition, if you have enough assets, you can make your own (identical) LifeStrategy fund but make it cheaper by holding the admiral shares of Total Bond (VBTLX), Total Stock (VTSAX), and Total International (VTIAX). They require at least $10k each and that would lower your overall expense ratio. However, you'd have to pay more attention to rebalance them as needed whereas the fund does that automatically for you, so you'd have to decide if the cost savings is worth making things more complicated.

Hello- I have been reading your lazy portfolio information and bouncing it against the Marketwatch information. It seems that you have great insight as far as these mutual funds are concerned. I was wondering if you could look at what I came up with after reading your information ... sort of a hybrid of the existing lazy portfolios.

I am 64 years old and will be investing for capital preservation and income mostly, although I don't really need the income per se. I have about $3,000,000 sitting in cash right now in Etrade.

There are certainly worse plans than that portfolio, but I would personally make some changes. First, your US/Foreign stock split seems fairly slanted to outside the US for some reason. This portfolio would not have performed very well last year. If I don't include REITs since they perform like a different asset class (and not looking at PRPFX as I don't know its exact composition), you would then have 33% US / 66% Foreign. It is recommended to have between 20-40% of your equities in foreign assets. Secondly, just looking at US equities, 25% of this is in the S&P 500, 25% in small cap value, and 50% in REITs. You really want such small exposure to the largest corporations in the US? I would also use Total Stock instead of simply S&P 500, which has 3344 holdings instead of simply 500 and thus is more diversified. You included VTSMX, which is total stock market, but then wrote out small-cap value, so I'm not sure which fund you actually meant. If you did mean total stock market, there's not much point to hold both S&P 500 and total stock and they are basically identical. Check the performance charts. You might as well combine holdings. I'm going to assume you meant small cap value, VISVX, though, going forward.

This portfolio overall would be quite volatile. Your REIT and small-cap value exposure is large. On the foreign front, there is a lot of overlap. All you really need now is Vanguard total international stock market - this contains developed and emerging markets and was changed in the last year or so to even include small-caps at market weight. You are using Pacific Stock and Developed Markets, which have overlap with each other as well as Total International. This would severely overweight developed markets and overweight the pacific region even more. Is there a reason you've adopted this strategy? If you want to overweight, you should simply hold developed/emerging in your desired percentages (or a pacific/european/emerging three fund approach) and get rid of total international all together as that simply causes confusion.

It clearly looks like you're striving for income since you're concerned with yield, but don't chase too much yield as it'll burn you. As they say, there's no free lunch. With more yield is usually more risk. I also have doubts as to the accuracy of the figures you presented above being up-to-date. I'd check the Vanguard website for the latest SEC yield. If you do want some more yield on the equity side, though, you could consider VEIRX (Equity Income Fund Admiral Shares). Although it's an active fund, which I typically don't recommend, it at least has a low expense ratio (0.22%). Due to its active nature, it's probably best placed in a tax-advantaged account. Your 10% allocation to permanent portfolio is a bit random and would cause some people pause, but I think it's reasonable to try a different strategy with a portion of your funds, so don't mind it myself.

On the bond front, note that Vanguard high yield corporation has volatility much like equities, so it's something to be aware of in case that causes you concern. There is a lot of debate on if high yield (i.e. junk) bonds have a place in one's portfolio, where some suggest it makes more sense to take risk on the equity size but others have a differing opinion on the matter.

On another note, you would be eligible for admiral status with your portfolio size and thus pay lower expenses. Are you planning to keep your money at Etrade? If so, I'd recommend using the corresponding ETFs (where available) instead of the funds as the commission fee is probably less and their expense ratios are competitive with the admiral share class. If you're basically using all Vanguard funds, though, I think it'd make sense to move the money to Vanguard and just make it easier and avoid any transaction fees in the future.

Based on the above tweaks, I think a more reasonable portfolio would be something like the following (see next post):

Using Admiral Class and ETF ticker symbols and SEC yield from Vanguard's website, the following portfolio makes more sense in mind as it simplifies matters without decreasing diversification, eliminates most overlap, and brings the overweight of foreign equities and REIT/small-value back to reasonable levels. Obviously, you should modify it as you see fit:

I actually made a typo and actually meant Total Stock Market so your assumption was on the wrong fund... but I understand what you are saying totally.

I believe that I leaned toward foreign because I am chasing dividends. I was hoping to achieve about 3%+ yield on my portfolio.

In the past I invested solely in VFIIX which was a morningstar 5 star fund with a price that fluctuates very little... and had reliable dividends every month. I wonder why nobody recommends it in any of the lazy portfolios? There must be a reason why those portfolios did not include this GNMA fund.

I didn't know about the admiralty verion of the funds so that point is noted. I will review what you have told me and select a better portfolio which is less volatile and I will let you know what I finally decided. Thank you again.

Hello again. After considerable thought, here is what I came up with. Hopefully it addresses your concerns and will meet my needs so I can basically forget about it except for re-allocation a couple times a year.

You're welcome Paul. That portfolio looks pretty good to me for somebody who wants investment income. It's low-cost, diversified, and relatively easy to manage and rebalance. You could tinker with the percentages forever to try to make it perfect, but in the end there is no perfect portfolio and at some point, you simply have to choose your allocation and stay the course.

Just note that you are clearly overweighting some asset classes in your quest for more yield, which is fine, but usually comes with additional risk. So, as long as you're comfortable with it, then I say, go for it! But your bond portfolio will have more volatility than a 100% Vanguard Total Bond portfolio.

As to your question above as to why hardly any Lazy Portfolios recommend the GNMA fund, I don't know the exact answer but some people are wary of mortgage backed securities. I think a 10% allocation to the fund is reasonable, though. This fund is a bit controversial, and will not do well in an environment of rising interest rates, but has certainly provided consistent returns over the years. For a debate/discussion on this fund, see this thread:http://www.bogleheads.org/forum/viewtopic.php?t=37057

A poster there describes it better than I can:"Virtually all US Mortgage Backed Securities (and that would include these) have repayment risk (interest rates go down) and extension risk (interest rates go up). This is called 'negative convexity' in the jargon. Basically this means the duration of each bond moves against you when interest rates move. The flipside is you get paid a higher yield-- the market is paying you for taking on that risk (you've given an option to the borrower to repay at their discretion, not yours). But it means when interest rates do a big shift, you get more hurt (or less helped) than Treasury Bond holders."

Note that E*Trade may not have Vanguard Admiral funds available to their customers, so that's something to look into. If that's the case, I'd use the ETFs or move my money to Vanguard since you're choosing to use Vanguard's funds. That would make life easier in my mind (although Vanguard sometimes requires a fair amount of paperwork for the initial transfer, which can be annoying, but once it reaches a steady state, I've found Vanguard to be a great experience.)

Overall, you proposed portfolio is better than what 99% of professional advisers would tell you what to do as they would (typically) put you in high cost investments that augment their pocketbook and not yours. Good luck!

Ok you convinced me.... I reduced vusux and vweax to 5% and increased vbtlx to 20%. Etrade doesn't offer the Admiralty shares of these funds, as you mentioned, so I will go with the available ETF's and the Investor Share equivalents where ETF's aren't available.

I don't feel like going through the hassle of moving out of Etrade since I have it set up for moving money in and out of various banks accounts around the world. I like the flexibility with their debit card (which they pay terminal fees-- over here in the Philippines and elsewhere in Asia I pay as much as $5 to use an ATM with a US Card).

Once again, thank you very much. I intend to read your entire blog cover to cover when I have time. I have never seen such clear and concise information anywhere on the web as what I see on your site. I'm sure you are helping many people (like myself, who really doesn't have time to devote a lifetime to study-- and who is suspicious of these gimmicky investment newsletters). I always viewed those investment gurus like those horserace handicappers on the radio who offer "tips". Of course, half of the advice wins and the other half loses, but you never hear about the losers. At any moment in time you can win or lose by buying or selling. Who wants to gamble with money that it took a lifetime to earn?

Great forum, I really have been able to gain valuable knowlege with your insight and investing philosphy. A few questions I am struggling over. With the recent Fed action, would it be wise to up TIPS to Total Bond Fund to a 50/50 split, or do you recomment holding half the amount of TIPS in relation to Tolat Bond Fund as I have presently.

And with further thought, is the Vanguard short duration TIPS fund (VTIPX) worhty of consideration if I am 10 - 15 years out from retirement? I am considering upping my bond allocation 5% from monies in the MMA, putting that 5% amount to short term TIPS (VTIPX) for added short term duration bond weight and a 50/50 split TIPS to Total Bond Market, wise? Better to simply add to or hold the VIPSX for the full duration (10 years) than have a secondary short term TIPS fund? Your thoughts?

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